Sharp pullback to 50-day MA in uptrend

Many of the same successful trading patterns that dominate equities trading can be transferred to the Forex markets. Moving averages, pullbacks, historical volatility and RSI can be used in both markets to time reversal moves and breakouts.

Let's take a look at a common pullback strategy which can be used in the Forex markets to find the right price to buy in. When an index or futures market (and in this case, a currency) pulls back to a significant moving average, the moving average often acts as a level of support that the price then bounces off of. The price is moving in a steady uptrend, moving higher as the moving average follows behind, and the pullback is a staging area for the next move.

We will use a 50-day simple moving average (SMA), to highlight a longer term swing trade. The GBP/JPY chart shows a solid uptrend since the beginning of May. From April 27-May 4, the Pound gained steadily over the yen, breaking highs from a few weeks before but getting stopped at resistance from highs in February (not shown). After testing these highs, the currency initiated a pullback to break support at its 50-day simple moving average, a move which could be considered a very risky pullback entry opportunity. Because price broke support at the 50-day SMA, this entry is more risky because there is much less technical support at these levels. A few days later GBP/JPY initiated another smaller pullback to the 50-day SMA, and this would have been our optimal entry point after the stock found support at its 50-day SMA twice within a short period of time.

Here is another example of a Forex market pullback to the 50-day simple moving average. In December '05 the Euro rallied strong against the Swiss Franc, easily rallying through the 50-day moving average resistance. A sharp pullback brought price back through the 50-day, where the Euro started to rally again, this time much more gradually. The Euro tested, broke and then held the 50-day in a small, consolidating pullback. Unlike the example from above, this pullback is a little riskier because price actually broke the moving average during the pullback. However, the Euro was trading above the average during the second pullback, and after two strong moves, it would be right to wager that this price is working to stay bullish.

As we know from buying stocks and futures on pullbacks, many times price will take a rest during an uptrend move, and fall back a couple of points. Because the stock or currency is trading in a strong uptrend, this pullback becomes a resting point before the price makes a continuation move in its original trending direction, especially if the pullback occurs next to a major moving average.

John Patrick Lee